Housing market risks unraveled

While the nation is consumed with talk of a potential housing-price bubble, an industry trade group today said that when sizing up the possibility of a real estate market downturn, act with caution not panic.

"There are risks, but they are far less dramatic than the hyperbole of recent months," said Doug Duncan, chief economist for the Mortgage Bankers Association. Duncan co-authored a report, "Housing and Mortgage Markets: An Analysis," released today.

Housing price growth will slow, Duncan said, and he expects a flattening in the decline of home-loan delinquencies with "possibly even a slight upturn." All of this will modestly impact the U.S. economy, but it's important to note that the housing and financial markets are fundamentally sound, he said.

The booming housing market is increasingly viewed as a pending problem, putting debates over whether a housing bubble exists back in the spotlight. People everywhere are talking about the possibility of price crashes and wondering what will happen to borrowers who've used risky non-traditional loan products to obtain their homes and the lenders who originated those loans.

The MBA paper notes that a LexisNexis search for the term "housing bubble" for July 2005 returned more than 650 news articles.

The purpose of the 30-page analysis of housing and mortgage markets, Duncan said, is to put the flood of housing market commentaries and analyses into perspective, review the risks and discuss the systems in place to help mitigate risk.

"There's been a crescendo on the issue of house prices since about 2001, and it's been supplemented in the last year with additional information and inquiries with regards to the development of new mortgage products," Duncan said.

The MBA's analysis comes on the same day the National Association of Realtors released home sales figures for July 2005. According to the NAR, total existing-home sales – including single-family, townhomes, condominiums and co-ops – slipped 2.6 percent in July to a seasonally adjusted annual rate of 7.16 million from a record of 7.35 million in June.

The national median existing-home price for all housing types, meanwhile, was $218,000 in July, up 14.1 percent from July 2004 when the median price was $191,000 and up about 0.5 percent. The median is a typical market price where half of the homes sold for more and half sold for less.

Positive economic factors such as low interest rates and strong local employment growth can explain home prices and the differentials in appreciation rates across the country, the MBA analysis concludes.

While the trade group is not predicting a housing-price crash, it does predict a sharp decline in housing-price growth next year, with average appreciation levels dropping to between 4 percent and 5 percent from this year's double-digit appreciation rates, Duncan said.

The housing boom also has created a significant increase in speculative investing in certain markets, the MBA paper notes. Data sources disagree on the extent of the increase, but MBA cautions lenders to monitor the level of speculative activity in certain markets.

In addition to house-price growth and speculative investing concerns, the development of new mortgage products such as interest-only loans and new types of adjustable-rate mortgages has some worried about the long-term outcome when interest rates rise or borrowers find themselves unable to adjust.

Federal Reserve Chairman Alan Greenspan recently said the increase in these types of loans is a concern. "Some households may be employing these instruments to purchase homes that would otherwise be unaffordable, and consequently their use could be adding to pressures in the housing market. Moreover, these contracts may leave some mortgagors vulnerable to adverse events," Greenspan said.

But there are a number of factors that work to mitigate these risks, according to the MBA analysis. For example, there is an alignment of incentives among the borrower, lender and the investor, Duncan said. Each has a stake in the borrower making mortgage payments and the alignment limits the extent of problems caused by any potential downturn.

Duncan said sharing of incentives is why the trade group suggests mortgage borrowers see a lender before seeing a real estate agent. Agents have no stake in loan delinquency once the house is purchased, he said.

Ultimately, borrowers should be sure they are wisely managing the risk associated with new loan products, the study concludes.

Duncan noted six risk factors MBA monitors in examining housing and mortgage markets. They are a high and sustained rate of home-price growth, declines in employment, a significant share of investor and speculative activity, a significant share of condo sales relative to total sales, an unusually large proportion of loan products that expose borrowers to potential payment shocks, and an unusually large proportion of Alternative-A loan products, which offer variances in the amount and quality of documentation required to borrow money.

Duncan said MBA does not rank local markets in terms of risk of price declines because housing markets are driven more by local factors than by macroeconomic factors.

"In addition, there are a number of factors that mitigate those risks," Duncan said, furthering the group's stance that the housing and mortgage markets should be looked at with caution, not panic.

The economist pointed to a healthy economy, growing household net worth, and a strong and well-capitalized banking sector as things working to mitigate risk in the housing market. He also said that effective regulatory oversight, widespread use of technology and the alignment of incentives among borrowers, lenders and investors are positive forces.